Neighborhood Effects in Mortgage Default Risk by mcy15867


									  Neighborhood Effects

in Mortgage Default Risk

                     Prepared for:

U.S. Department of Housing and Urban Development

     Office of Policy Development and Research

                  Prepared by:

               Robert F. Cotterman

           Unicon Research Coporation

                Santa Moncia, CA

          Under Contract: C-OPC-18484

                  March 2001


The author wishes to thank the staff of HUD Policy Development and Research, who
have provided invaluable advice and assistance throughout the course of this project.
Special thanks are due to Harold Bunce, Bill Reeder, and Sue Neal for extensive
comments on an earlier draft and to Randy Scheessele for help in obtaining and
understanding the FHA data.

The contents of this report are the view of the contractor and do not necessarily reflect
the views or policies of the U.S. Department of Housing and Urban Development or the
U.S. Government.

        This study examines the effect of neighborhood characteristics on the default of
FHA mortgages. The analysis includes both neighborhood characteristics and
characteristics of the individual loan and borrower, so that the effects of the
neighborhood can be distinguished from those of the individual loan. In particular, the
analysis seeks to distinguish the effects of neighborhood race, ethnicity, and income
from the effects of the of the individual borrower's status. Research on the effects of
neighborhood characteristics on default has been somewhat limited in the past, and this
study's contribution to the literature is the inclusion of credit history data. The analysis
finds that lower tract income and higher tract black composition are associated with
higher rates of default, whereas individual borrower race or income are unrelated to

        The study then goes on to examine possible causes for these findings, including
whether higher defaults reflect more limited access to mortgage finance (as measured
by refinance probability) or a response to previous defaults in the neighborhood. The
findings regarding access to refinancing are not definitive. FHA refinancing probabilities
seem to be higher in minority tracts and are a least equal to low-income tracts.
Refinancing through other non-FHA sources of refinance funds, including conventional,
is statistically less in predominantly Hispanic and lower-income tracts for holders of FHA
mortgages. The effects of neighborhood race and income on default are reduced when
lagged defaults and prepayments and neighborhood house price change are included in
the analysis. Although the higher default rate in lower-income tracts remains significant,
the higher default rate in minority tracts becomes insignificant, suggesting that lower
house price appreciation is an important factor in the higher default rates observed in
minority neighborhoods.

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